October 16, 2002

In a philosophy class a lifetime ago I was told that how people described the future indicated a great deal about how they will act in the present.  If the future is described as amazing, holding opportunities, and offering promise, then consumers will spend and investors will take on risk. 

If, by contrast, the future is described as continuous conflict, struggles, and fearful; then people become more protective and preserving in the present.  The flight from stocks to treasury bonds in recent weeks strongly suggests that fear rather than hope is dominating our outlooks. 

Of course, fear could be justified and protection could be appropriate.  However, fear can also create conditions that might not occur if more optimism was present.  One of the great quotes that we learn in school about the Great Depression is that "all we have to fear is fear itself."

Should we be fearful economically at this time?

It certainly would help if we were debating economic policies that addressed those fears or received explanations for why prevailing policies will or are working.   Treasury secretary O'Neill has argued that the economy is basically sound (i.e. policies are working) but every consecutive week that stock values fall increases questions about the appropriateness of that position. 

The President, in arguing that his tax cuts should be made permanent, tacitly admits that his original proposals for phased in cuts were not appropriate.  We continue to wait for any results from his summer economic summit, which also suggests that not everything is right with the economy. 

Alan Greenspan, chairman of the Federal Reserve, admits that weakness rather than strength is more likely in the next few months; but he makes no changes in policy to address this prospect. 

With so little direction from policy makers (including the Democratic opposition, who provide very few policy initiatives of their own), I should like to address whether policies are needed and what they are. 

Secretary O'Neill is not too far off-base in his assessments.  The inventory excesses have been eliminated.  Undesirable capital spending, especially in telecommunications and internet infrastructure, have been halted.  Job losses have created some excesses in office and apartment construction, but the markets already are responding to these problems by reducing activity. 

Although there remains a danger that lost paychecks will lead to reduced consumer spending, the workweek for those with jobs has been expanding.  As a result, inflation adjusted purchasing power continues to expand about 2 percent per year. 

Inflation itself has been subdued except in a few pockets of health and education and in some commodities, such as energy.  Even with rising gasoline prices, consumers have more jingle in their pockets than a year ago. 

Unfortunately, tax cuts that would further support consumer spending either were distributed last year or must await 2004 for more reductions.  Instead of worrying about whether his tax cuts are permanent, the President should be arguing for advancing the 2004 cuts to January of 2003, when they would be very welcome indeed. 

Of course, what happens with Iraq remains a major uncertainty.  How much would a war cost?  What would be resolved by it?  How many resources must be diverted to the Middle East to ensure that a regime change is more than a change in the tyrant's face?  How many body bags will be needed?  There are no pleasant thoughts in any of these prospects.

Although all conflicts can lead to economic surprises, the magnitude of our costs appear to be manageable. 

The uncertainties are creating more economic hardship than even worst case projections suggest will be created by a conflict.  Virtually every retailer is lowering sales estimates for Christmas.  Though the West Coast labor strife is also mentioned, Iraq is what they believe is most worrisome to their customers. 

The other concern is that consumer spending is too large relative to the net worth of households.  A plunging stock market merely intensifies that worry.  As I mentioned in the past, consumers will spend as long as the cost of servicing their debt does not rise relative to their income. 

To insure consumer involvement, I would push for even lower interest rates in the short run.  Only after corporate credit worthiness begins to improve and corporate spending rebounds would I worry about increasing interest rates.  After all, any rate increases will begin to undermine consumer ability to service their debt.

I would allow full write-off of investment losses against current incomes for investors.  Capital gains would be eliminated, but the investment costs against which investment income is compared would be increased by the rate of inflation from the point of acquisition of the investment. 

At least, those are the proposals I would make.  And then I would remind Americans that our economic system is sound, our banks have lending capacity, and all we need is a better belief in our future. 


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